In financial terms Fundamental Analysis is a process where we dig deeper into the company to get an idea of the business model, future growth prospects and the financials as well.
It is divided into 2 parts:
- Qualitative Analysis
- Quantitative Analysis
We start with the Qualitative Analysis where in we get into the details of quality of the company on the basis of the management, products and the business model.
So we start by studying the sector which helps us get an idea of how the particular sector is performing. It helps to relate to the business model of a company within a particular sector.
Then, we study the business model of the company which shows us how the business works does it work on credit or in cash. For example restaurant business works in cash and the Real estate business works on credit.
Our next step is to get to know about the products or the services that the company is offering where we try to figure out any competitive advantage of the company over its peers.
Having a competitive advantage helps a company to survive for a longer term and have control over its peers in respect to pricing power. Like for example Amul cheese has an advantage over its peer like Britannia.
Having a fair idea of the management is also necessary while evaluating a company as it is the dynamic and efficient management that drives the growth of any company. We need to follow the management commentaries over the past years to have an idea whether it is fulfilling its promises and statements or not.
For example the Bajaj Auto management said in an interview that it will increase the market share by reducing prices which will help it to increase its profits when no one else thought of it and this worked for the company.
We then start with the Quantitative Analysis, where we tend to check the financials of the company just as we check the pricing of the flat by analyzing the right price prevalent in that area.
We start by checking the Profit & Loss A/C which shows us the profitability of the firm. We have a look at the Revenues and Expenses which the company is incurring. From the P&L statement we get an idea of the profit it generates after paying off all its operating and non operating expenses.
The Balance Sheet shows us how the company is utilizing its equity capital, debt and its assets to generate profits for the business.
The Asset side shows the various assets that the company owns and uses to generate revenues from it and the Liabilities side shows the various sources of capital along with the various obligations that company has towards its lenders.
Then the Cash Flow Statements gives us an overview whether the company is cash rich or not. The Cash from Operations shows whether the business has been able to generate cash from its core business operations or not.
Cash from Investing Activities shows us the cash used or generated from its investments. Cash from Financing activities depicts the outflow or inflow of cash from its various financial transactions like Payments of Dividends, Interests Paid on Loan etc.
Finally, comes the comparative analysis of various valuation ratios which tells us whether the Stock is fairly priced or not compared to its Current Market Price.
For this we mostly use (03.57) PE ratio or the Price to Earnings Ratio which depicts the price an investor is ready to pay over its earnings per share. It is calculated by dividing the Current Market Price divided by Earning Per Share. Lower the PE ratio compared to its peers more undervalued is the company.
EPS or Earnings per Share shows us how much portion of a company’s profit is allocated to each outstanding share. It is an indicator of the company’s profitability. It is calculated as Net Profit divided by Weighted Average Number of shares outstanding. (04:25). Higher the EPS compared to its peers better is the company. (Wrong statement) — delete
Price to Book ratio indicates how much shareholders are paying for a company’s net assets. It gives an estimated value of a company if it is to be liquidated. It is calculated by diving Current Market Price per share by Book Value per share. Lower the Price to book ratio compared to its peers more undervalued is the company.
The Price to Cash Flow ratio is used by investors to evaluate the attractiveness of investing in a company’s shares. As cash figures are hard to manipulate, this ratio can be more reliable. It is calculated by dividing Current Market Price by operating cash flow per share. Lower the ratio compared to its peers more undervalued is the company.
Finally we also take a look at the Dividend Yield which shows us the ratio of a company’s annual dividend compared to its share price. Though it does not fall under Valuations, but it is important to get an idea whether a company pays back some part of its Earnings to its shareholders or not.
Thus a company which pays dividend is expected to have a positive cash flow and preferred by investors.
After going through all these we finally choose a stock with good future growth potential, a good management and fair price.
Thus Fundamental Analysis is indeed a long and tiring process but it certainly helps us to create wealth if we do our homework prudently before investing. Thus all these processes should be followed judiciously and understood properly if we are to create wealth for ourselves on a longer time frame. Because remember Rome was not built in a day.
Thus Invest Right and Sit tight.
Thank you for watching the video.
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